Bernanke Says Banks Underreporting Libor Very Troubling

Chairman Ben S. Bernanke defended
the Federal Reserve’s response to manipulation of the London
interbank offered rate, saying the Fed cooperated with other
regulators and suggested a fix.

“The investigations took place, but they were taken up
quite quickly by not the Fed, which is a safety and soundness
regulator, but by the authorities that had the most direct
responsibility for those issues,” Bernanke said in testimony
today to the Senate Banking Committee in Washington. The Federal
Reserve Bank of New York “took the lead” and “informed all
the relevant authorities” in the U.K and U.S.

Regulators in both countries have defended their reaction
to the manipulation of Libor, the global benchmark for $500
trillion of securities, after Barclays Plc (BARC) was fined a record
290 million pounds ($453 million) for rigging borrowing costs.

The New York Fed last week released documents showing it
knew Barclays underreported rates and that Timothy F. Geithner,
then the president of the regional Fed bank, sent a memo in June
2008 to Bank of England Governor Mervyn King recommending
changes to how Libor was calculated.

“What you come away with is ‘Look, we turned it over to
the responsible people in Europe -- we did our job,’” said
Robert Eisenbeis, chief monetary economist at Cumberland
Advisors in Sarasota, Florida. While Fed officials “could have
done more,” they are making it “pretty clear that this is the
Brits’ problem.”

Deliberate Misreporting

Geithner, now U.S. Treasury secretary, advised King in the
memo to “establish and publish best practices for calculating
and reporting rates, including procedures designed to prevent
accidental or deliberate misreporting.” He made a total of six
suggestions.

King told Parliament’s Treasury Committee today in London
that he only knew of wrongdoing two weeks ago and that
Geithner’s memo in 2008 didn’t highlight malpractice.

“Mr. Geithner was sending that to us as a suggestion for
how these rules should be constructed and we agreed with him,
but neither of us had evidence of wrongdoing,” King said. “The
first I knew of any alleged wrongdoing was when the reports came
out two weeks ago.”

The Fed didn’t have information to suggest that banks were
manipulating rates “for profit,” only that some were
“possibly submitting low rates to avoid appearing weak” during
the financial crisis, Bernanke said. Still, misreporting of
Libor is “very troubling,” he said.

Bernanke was questioned by lawmakers as to why the central
bank didn’t act more aggressively. Senator David Vitter, a
Republican from Louisiana, said it appears the New York Fed
“reacted on the policy side with various discussions” and
recommendations.

Big Banks

“I haven’t seen anything about it reacting as a regulator
of large U.S. banks,” Vitter said. “Did it do anything to
investigate whether U.S. banks were guilty of the same
practice?”

Bernanke said the Fed doesn’t know that U.S. banks are
innocent of rate-rigging.

“If we don’t know that, it seems like somebody dropped the
ball, the fact that we’re four years later and we don’t know
that,” Vitter said.

The New York Fed knew “some banks” were potentially
understating submissions for Libor as early as 2007, according
to a statement posted on its website last week. A Barclays
employee told a New York Fed staff member in April 2008 that the
U.K.’s second-largest lender was underreporting its rate to
avoid a “stigma,” the Fed district bank said.

Markets Director

Geithner’s proposals were passed along to the British
Bankers’ Association by King and Paul Tucker, at the time
markets director of the U.K. central bank, according to
correspondence released by the Bank of England.

“The Libor system is structurally flawed,” Bernanke said
in testimony today. “It is a major problem for our financial
system and for the confidence in the financial system, and we
need to address it.”

An “international effort” is needed to fix the Libor
problem, and potential changes could include increasing the
“visibility” to lower the ability of individual banks or
traders to affect the rate, he said. Switching to an
“observable market rate” may also help, though Libor is “very
deeply ingrained in many contracts” so that change may be
difficult.

Bernanke said the New York Fed “responded very quickly”
and “informed all of the relevant authorities.” The district
bank “took the lead here,” while the Fed’s Washington-based
board was “in supporting mode,” he said.

Setting Libor

The New York Fed released the documents last week in
response to a request from Representative Randy Neugebauer, a
Texas Republican who serves on the House Financial Services
Committee, for transcripts of communications with Barclays
relating to setting Libor from August 2007 to November 2009.

Libor is calculated from a daily survey carried out for the
British Bankers’ Association, in which the world’s biggest
lenders are asked the rate they’re charged to borrow over a
variety of short-term maturities in currencies including
dollars, euros and yen. Banks have been accused of low-balling
submissions for the benchmark during the financial crisis.